Cash & Liquidity ManagementCash ManagementAccounts ReceivableReconciliation: The Transaction Challenge For Financial Institutions

Reconciliation: The Transaction Challenge For Financial Institutions

Reconciliation of transactions is one of the critical operations in every financial institution and the effective management of this activity is essential to the success of an organisation. The main objective of performing reconciliation is to identify incompatibilities in data and achieve resolution.

Reconciliation is an important function in the areas of cash management, payment processing, GL accounting, pre- and post- trade settlement, position management, confirmations and risk and compliance management.

Banking Operations

Cash management

Timely bank reconciliation would allow effective management of payables and receivables thereby enabling timely management for optimum utilisation of cash. This includes identification of suitable opportunities to capture revenue and more efficient use of cash resources.

Validating financial statements

Uniform Commercial Code regulates all the activities between the client and the business institution. It expects the business clients to notify their banks of any statement discrepancies that may point to an error or fraud. The account holder/client lose the rights to claim in case of any errors in their financial statement. Proper reconciliation management might help identify possible process gaps and rectification of the same.

Risk management

Reconciliation acts as one of the means in achieving the goal of risk management that is protection of corporate assets and minimisation of losses. Highest priority is given to exceptions arising out of reconciliation process, which could lead to cash loss by the organisation. Effective reconciliation process also avoids any unwanted reputation loss to the organisation through timely settlement.

Compliance risk

Proper bank reconciliation helps banks in spotting unusual and suspicious banking activities like deposits recurring at a particular period of time in the customer accounts, wire transfers in huge sums from overseas accounts, etc. With a prior knowledge about customers with KYC policy, banks may be able to spot fraudulent activity.

Trading Operations

Front office

Front office operations include trade order management, capture and execution, deal structuring, data reception and distribution, pre-trade compliance, portfolio analytics, etc. Scope for reconciliation comes in the trade validation process wherein the structure of the agreed trade is checked against the corresponding booking into the front office system. Daily reconciliation process is executed to ensure the matching of front and back office records to sort discrepancies arising out of manual error during input.

Middle office

Middle office operations include risk management, position management, post-trade compliance, settlement and trade matching:

  • Funds reconciliation: Cash management prepares day-to-day reports of the cash balance at the close of business. Reconciliation solution compares the actual receivables and payables with those positioned to be paid/received for the particular value date. This effectively sorts out any likelihood of overdraft positions in the nostro account and also identifies any unused funds lying in non-interest bearing accounts, which could be invested elsewhere to reap benefits to the organisation.
  • Pre- and post- settlements: Pre-settlement involves confirming and reconciling future deal coupon flow projections of the bank with those of the counterpart bankers. This is the initial process wherein possible differences in the settlement are identified. Post-settlement process identifies real time exceptions arising out of reconciliation process and thereby continues with the aid of an exception management system for effective analysis and resolution of the discrepancy.
Back office

Back office operations include confirmation, profit and loss (P&L) calculation, trade inventory, custodian services, collateral management, transfer agency, client reporting:

  • P&L calculation: In general, P&L refers to the income, expenses and the net profit of the organisation. This acts as an indicator of trading floor performance in capital markets. It is calculated on a daily basis to measure and validate the results of daily transactions done and to realise and allocate the profits arising out the deals, to the corresponding trading area/network. Reconciliation requirements exit in P&L calculation at the following levels:
    • Perform daily P&L verification between official P&L and General ledger
    • Perform daily balance sheet verification and management
  • Confirmation matching: The confirmations department is responsible for the preparation, execution and delivery of the document framed as per ISDA rules, and also the matching of the document received from the counterpart, reconcile them and sort out any possible discrepancy arising out of the terms of the trade. Effective confirmation reconciliation would help resolve any possible discrepancy or erroneous booking of the trade at its infancy.

Key Challenges in Reconciliation

Managing increasing trade volumes

Currently, financial institutions and investment banks face the challenge of ever increasing volumes of trade transactions to be reconciled and the complexity of new instruments coupled with regulatory compliance demands and also the need to reduce the inefficiencies in their operations.

Reducing manual reconciliation errors

The need to reduce manual errors during reconciliation is of utmost importance to reduce potential operational risk and thereby minimise operational cost without hindrance to the normal processes.

Achieving data consistency

Achievement of consistency in trade processing, data management, accounting to comply with standards, clearance and settlement, control and compliance should be able to define an integrated process flow management within an organisation.

Diversified environment

Another major challenge facing the reconciliation analysis is the emergence of new asset types and structured deals with more complex technicalities and calculations involved, which would require modification/improvement of existing systems to accommodate reconciliation of such complex and diversified deals.

Reconciliation Solutions

Traditional approach

The traditional approach is manual reconciliation, which is still being followed in many financial institutions. In this approach, the records are manually entered, compared, analysed and the exceptions are stored separately. Manual process is more tiresome because of increasing volumes of the data. This may also be prone to more errors.

Tool-based approach

The tool-based approach overcomes important challenges and drawbacks that can be found in the traditional reconciliation approach. Through automation, errors due to manual reconciliation can be greatly reduced. The outcomes will be more efficient and faster with integrated exception handling. For instance, the ideal reconciliation process should be able to link the order management system and payment system to automate reconciliation process and engage manpower for exception handling, which would require analytical skills according to the type of discrepancy involved. This situation provides the ideal platform for financial institutions to engage skilled staff in resolving complex discrepancies and real-time reporting of cash flow positions and appropriate actions to minimise operational losses.

In the tool-based approach, exceptions can automatically generate queries and correspondence to be passed to internal/external counterparties via SWIFT, mail or fax and subsequent chasers or overdue reports prompts processors and management to keep effective control of the process. Some benefits of the tool-based approach include:

  • Control of data: Automated reconciliation workflow derives process convergence, resolution and reduction of errors and redundancies, increases productivity and compliance adherence.
  • Faster analysis: Saves effort in 90% of the processes associated with manual reconciliation.
  • Business rules: Automated matching process based on pre-set business matching rules. Automatic exception case creation for unmatched data.
  • Integrated tool: An integrated business solution provides better collaboration between vendors, banks and customers. This tool has a fully integrated exception processing.
  • Report generation: Automatic report generation highlighting mismatches and helps in manual analysis of predefined business rules.
  • Automated workflow: Automated workflow derives process convergence, resolution and reduction of errors and redundancies, increases productivity and compliance adherence.

Conclusion

Financial institutions’ processes, whether related to banking or trading, are undergoing new changes with an unprecedented increase of transaction volumes and a corresponding expansion in market information. This brings the need of effective data management solutions in the areas of reconciliation in order to have smooth ongoing operations. Demand for reconciliation solutions with optimum speed and performance coupled with uncompromising levels of accuracy, controls and data management is the foremost requirement for customer satisfaction. Financial institutions are envisaging an automated and integrated approach rather than a traditional approach.

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